Objectives in the Audit of Inventories and Cost of Good Sold
Cost of Goods Sold and Inventory
Posted in 6. Operations by Erin Lawlor on the September 7th, 2008 << Financials - Statement of Cash Flows | >>WIP Statement and Percent of Completion |
The purpose of an Inventory System in Financial Accounting is to account for resources and to match costs to their related sales as closely as possible. Management Accounting is more concerned with the details of inventory management but for Financial Accounting, when inventory is purchased or sold, the objective is to satisfy the Matching Principle and to accurately represent the financial position of the entity.
The Matching Principle requires that revenues and their related costs be matched up and posted into the same accounting period. When Inventory is purchased and before it is sold, there are no revenues to match it to so it cannot be considered a cost until it is sold.
The inventory examples assume that the entity has ownership of products purchased and that they are purchased and manufactured for sale as finished goods. There are cases where the entity purchasing materials for and accounting for a project are not the owners of the product even as it is in the process of construction or manufacturing. In these cases, purchases are debited directly to Income Statement Cost accounts. The key concept is ownership.
There are two systems used to account for Inventory, the Periodic System and the Perpetual System. Each has its own accounting methods and I’ll demonstrate those methods here. I will not be explaining Inventory Valuation methods (FIFO, LIFO, Specific Identification etc.)
Periodic Inventory System - Assumes Entity Owns Inventory until Sale:
The first system I’ll demonstrate is the Periodic System. The Periodic System may work well for companies where changes in sales can be tied closely to changes in inventory purchases. Under this system, as inventory is purchased, it is debited to the Income Statement Account “Purchases” and the Balance Sheet Account
Posted in 6. Operations by Erin Lawlor on the September 7th, 2008 << Financials - Statement of Cash Flows | >>WIP Statement and Percent of Completion |
The purpose of an Inventory System in Financial Accounting is to account for resources and to match costs to their related sales as closely as possible. Management Accounting is more concerned with the details of inventory management but for Financial Accounting, when inventory is purchased or sold, the objective is to satisfy the Matching Principle and to accurately represent the financial position of the entity.
The Matching Principle requires that revenues and their related costs be matched up and posted into the same accounting period. When Inventory is purchased and before it is sold, there are no revenues to match it to so it cannot be considered a cost until it is sold.
The inventory examples assume that the entity has ownership of products purchased and that they are purchased and manufactured for sale as finished goods. There are cases where the entity purchasing materials for and accounting for a project are not the owners of the product even as it is in the process of construction or manufacturing. In these cases, purchases are debited directly to Income Statement Cost accounts. The key concept is ownership.
There are two systems used to account for Inventory, the Periodic System and the Perpetual System. Each has its own accounting methods and I’ll demonstrate those methods here. I will not be explaining Inventory Valuation methods (FIFO, LIFO, Specific Identification etc.)
Periodic Inventory System - Assumes Entity Owns Inventory until Sale:
The first system I’ll demonstrate is the Periodic System. The Periodic System may work well for companies where changes in sales can be tied closely to changes in inventory purchases. Under this system, as inventory is purchased, it is debited to the Income Statement Account “Purchases” and the Balance Sheet Account